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PennyMac Financial Services, Inc. (PFSI) is a specialty financial services firm with a comprehensive mortgage platform and integrated business focused on the production and servicing of U.S. residential mortgage loans and the management of investments related to the U.S. residential mortgage market (source: PennyMac Financial Services Profile).

With the improving economy and housing recovery continuing, PFSI is well positioned for the future. PFSI completed an IPO on 5/9/2013 priced at $18.00 a share with a lockup period of 180 days. The lockup expiration ended on 11/15/2013.

The Business

PFSI conducts business in two segments: mortgage banking and investment management.

The mortgage banking segment is comprised of three primary businesses:

  1. Correspondent lending - manages residential mortgage loans for their own company and PennyMac Mortgage Investment Trust (PMT). Fees are earned for each loan acquired by PMT.
  2. Retail Lending - manages residential conventional and government-insured mortgage loans nationally allowing home refinancing through the Internet and over the phone (as opposed to having branches). Interest income is earned through the period of the hold and sale or securitization of loans.
  3. Loan Servicing - performs loan administration, collection, default activities, counseling delinquent mortgagors, modifying loans and supervising foreclosures.

The investment management segment is through the fully owned PNMAC Capital Management, LLC (referred to as PCM). PCM is an SEC registered investment adviser which develops investment strategies and sources and acquires mortgage loans and mortgage-related assets. For these activities, PFSI earns management fees as a percentage of net assets and incentive compensation based on investment performance.

The Fundamentals

PFSI is inexpensive based on its trailing 12 months statistics seen below (as of market close 1/31/2014). The company has no debt and is showing good growth trends. Earnings in 2013 are estimated at $1.42. The company reports Q4 on 2/5/2014. Earnings in 2014 are estimated at $2.10.

Valuation

Market Cap

$320.72M

P/E (Trailing 12 Months)

15.87

PEG Ratio (Five-Year Projected)

1.06

Price/Cash Flow (Trailing 12 Months)

2.3

Price/Sales

0.43

Price/Book

1.18

Profit Margins

Gross Margin

53.85%

Operating Margin

50.17%

Pretax Margin

46.52%

Returns

Return on Sales

15.06%

Return on Equity

41.03%

Return on Assets

6.25%

Return on Investment

10.19%

Sales/cost of goods sold have been in an encouraging uptrend while net income/cash seems to be decreasing to increasing portfolio size (see table below).

  • The mortgage banking revenue was up 6% in Q2 and down 25% in Q3.
  • The investment management was down 3% in Q2 and up 6% in Q3.
  • The servicing portfolio as whole was up 23% in Q2 and up 19% in Q3.

2013 (Q1 to Q3 only)*

2012*

2011*

Sales/Turnover (Net)

308

273

77

Cost of Goods Sold

142

142

58

Gross Profit (Loss)

165

131

18

Net Income (Loss)

8

118

15

All numbers in millions of dollars.

Ownership and Insiders

As of 9/30/2013, the following insider buy transactions were filed above the current security price. No sell transactions have been filed.

Click to enlarge image.

Insider ownership has increased since the latest 13D and 13G filings for the 9/30/2013 period as seen below.

Fund Event

#

Funds creating new positions:

11

Funds adding to a position:

23

Funds closing position:

10

Funds reducing position:

12

Of the top 10 institutional holdings by shares held, Leon Cooperman (Omega Advisors), T. Rowe Price Associates and Vanguard have all initiated or increased their holdings within the company. As of 9/30/2013, the total holdings and position value of the top 10 holdings was as follows:

Institution Name

Shares Held

%Change

Omega Advisors, Inc.

2,759,600

0

T. Rowe Price Associates, Inc.

932,597

+34.94

Vanguard Group, Inc.

606,992

+237.22

The Technicals

The technicals related to PFSI are still young considering an IPO mid-2013. However, the daily and the weekly chart seem to have found support between the $16 and $17 price range while the market takes a breather and the developments unfold with the Fed and interest rates.

Source: StockCharts.

Risks

The current market seems to believe PFSI is fairly valued at its current price. If mortgage volumes continue to decrease, revenue at PFSI will see a decline and growth will be stagnant. Mortgage originations are expected to fall in 2014. The Street's expectations vary on the amount of decline, but that could eat into PFSI's piece of the pie. A diverse business model should help PFSI generate revenue from the different business segments, but as mortgage interest rates rise, refinancing will potentially drop. On the other hand, institutions are still expecting purchase activity to remain strong for 2014. If mortgage volumes decrease substantially, rates continue to rise and the overall portfolio shrinks, I would recommend reconsidering the investment. As always, invest smart, scale in and don't be greedy.

Conclusion

PFSI is showing signs of growth in an environment that should favor its business in the future. I have initiated my position last week while observing the market weakness. The PFSI portfolio is in growth mode and I anticipate the price will appreciate in the future. This should be a longer-term investment, in my opinion. I will make an effort to provide update on my position. Any input, advice, recommendations and feedback is appreciated.

Source: PennyMac Financial Services: Future Upside Potential